Where Are We on Too Big to Fail?

Even in a week where headline-grabbing scandals seem to be dominating all of Washington's time, concern over "too big to fail" banks continues to simmer.

On Wednesday, the House Financial Services Subcommittee on Oversight and Investigations held its third hearing this year on TBTF issues. It will hold its fourth next week.

Later that day - and just down the hall - Attorney General Eric Holder walked back a comment he made earlier this year about some banks being "too big to jail" at a House Judiciary Committee hearing.

"I made a statement, I guess, in a Senate hearing that I think has been misconstrued. I said it was difficult at times to bring cases against large financial institutions because the potential consequences that they would have on the financial system," Holder said. "But let me make it very clear that there is no bank, there's no institution, there's no individual who cannot be investigated and prosecuted by the United States Department of Justice."

ADVERTISEMENT

"Let me be very, very, very clear: Banks are not too big to jail," he added.

They may still be "too big to fail," however--at least some regulators believe they are. "I think that 'too big to fail' is a very big issue, and we will not have completed the goals of financial regulatory reform unless we have adequately addressed this issue," Federal Reserve Chairman Ben Bernanke said last Friday.

He made a similar point in February when he told the Senate Banking Committee that "getting rid of 'too big to fail' is, I think, an incredibly important objective, and we're working in that direction." Just days before, Bloomberg had published an editorial calculating that large banks receive an implicit subsidy of $83 billion every year because it's cheaper for them to borrow than smaller banks that aren't believed to be backed by the government. That also got a lot of attention in Washington and on Wall Street, and revived the discussion over "too big to fail" that has been ongoing since the crisis.

Still, there's no agreement on whether the 2010 Dodd-Frank financial reform law, an attempt to shore up the nation's banking sector and clean up Wall Street in the wake of the crisis, solved "too big to fail" or enshrined it. Dodd-Frank requires the biggest banks to have so-called "living wills" detailing how they would unwind in the event of failure. It also gives regulators new tools to resolve or unwind a failed financial firm. Mary Miller, Treasury Under Secretary for Domestic Finance, said in an April 18 speech that Dodd-Frank ended "too big to fail."

"A common use of the too-big-to-fail shorthand is the notion that the government will bail a company out if it is in danger of collapse because its failure would otherwise have too great a negative impact on the financial system or the broader economy," she said. "With respect to this understanding of too-big-to-fail, let me be very clear: it is wrong."

"As a result of the comprehensive reforms passed by Congress and signed into law by President Obama, no financial institution, regardless of size, will be bailed out by taxpayers again," she said.

This did not make her popular with the economists and commentators who have been pushing for additional steps to break up the biggest banks, force them to hold more capital or put in place clearer plans for unwinding in the event of failure. Simon Johnson, for example, an MIT professor who has been outspoken on "too big to fail," wrote with colleague John Parsons in The New York Times, "Ms. Miller's argument rests on eight main points. On each there is a serious problem with her logic or her reading of the data, or both. Taken together, we find her position to be completely unpersuasive. Unfortunately, the problem of too big to fail still lurks."

Lawmakers like Rep. Patrick McHenry, R-N.C., the head of the House Financial Services Subcommittee on Oversight and Investigations, agree. McHenry has made ending "too big to fail" a focus this year.

"The fact is that Dodd-Frank did not end too big to fail, but instead enshrined it," he said at Wednesday's hearing.

The proposal for addressing TBTF -- and there are several, including one out this week from the Bipartisan Policy Center and another the Dallas Fed released this winter -- that has received the most attention of late is one introduced last month by Sens. Sherrod Brown, an Ohio Democrat, and David Vitter, a Louisiana Republican. Brown and Vitter's legislation would impose higher capital standards on large banks. Critics say it's an overly blunt approach for the nation's complex banking system. But the proposal has garnered much attention in Washington and renewed again a conversation about TBTF -- even though political analysts such as those at the Eurasia Group say it's unlikely to go anywhere on Capitol Hill.

"Congress is unlikely to pass any anti-TBTF legislation... but regulations are likely to start working to limit the size or scope of such institutions, by raising their funding, compliance and transaction costs," Dan Alamariu and Samantha Grenville of the Eurasia Group wrote in a note this week. There's a feeling that Democrats don't want to reopen the contentious Dodd-Frank Act, for fear of unleashing a torrent of changes, particularly before it's been fully implemented. More than half of the rules required under the law have yet to be finalized.

Still, as the third anniversary of the Dodd-Frank approaches in July, expect discussion over whether the law adequately addressed "too big to fail" to only grow louder.